The euro: has Brexit strengthened the single currency?

Having risen by more than 10% against the US dollar over the past 12 months, the euro (EUR) is pausing for breath at the start of 2021 – much to the delight of eurozone exporters, who were put under severe strain last year.

Despite a slight fall against the pound sterling (GBP) following the free trade agreement signed between London and Brussels, the single currency has, all things considered, held up rather well against Brexit so far.

Nevertheless, whilst it is tempting to imagine that the UK’s departure from the European Union will have only a limited impact on the single currency in the coming months, given that it is not part of the eurozone, things are not quite so simple, and the close trade ties woven across the Channel could well tip the balance in the medium to long term. Here’s why.

A limited direct impact, but very real economic consequences

At an institutional level, Brexit entails the United Kingdom’s withdrawal from the European System of Central Banks (ESCB), which brings together the European Central Bank (ECB), the central banks of the nineteen eurozone member states, and the nine central banks of EU member states that are not part of the single currency area – the Bank of England (BoE) belonging to this latter group.

Nevertheless, whilst the United Kingdom had obviously never joined the eurozone, it was not part of the European exchange rate mechanism linking the national currencies of member states (outside the eurozone) to the single currency either. For this reason, the entry into force of Brexit, followed by the signing of the trade agreement between the EU and its former member state on 24 December, had only a limited direct impact on the value of the euro.

Brexit, on the other hand, has very real consequences for the European economy, which are influencing – and will likely continue to influence – the value of its currency. To name just one example, EU member states must now reckon with a shortfall of nearly €60 billion in their budget forecasts by 2027!

A balance of power that favours the euro

Since the referendum on the United Kingdom’s membership of the European Union on 23 June 2016, UK financial markets have on average underperformed those of the eurozone (which was not the case before the vote). For example, the MSCI United Kingdom Index has fallen by 8% since the date of the referendum, whilst the eurozone index has risen by nearly 32%.

Furthermore, the pound sterling, which was worth €1.3089 at the time of the Brexit vote, is now worth only €1.1285. Despite the numerous uncertainties involved in the departure of a key trading partner, the single currency has thus so far retained all of its strength and stability.

Movements in the GBP/EUR pair

The GBP/EUR pair has been highly volatile over the past two decades. The most dramatic fall occurred during the 2008 financial crisis, when the pound sterling lost almost 40% against the single currency, falling from 1.60 to 1.02 by the end of December 2008 – which remains, for the time being, the rate closest to parity. After this collapse, between 2009 and 2014, the pound sterling gained strength and traded within a range of 1.10 to 1.25. 2015 was a sign of an upturn, with the pair trading at around 1.35-1.40. A fresh collapse (-25%) in 2016 (the British vote in favour of Brexit) reversed the previous year’s upward trend, with a return to 1.10, and for the past five years the pair has oscillated between strong support at 1.08 and heavy resistance at 1.20.

On both the stock market and currency fronts, the advantage (or the lesser evil) seems to lie with the eurozone so far. But what about the economic front?

Whilst it is still too early to precisely quantify the economic consequences of Brexit for the eurozone, it is nevertheless possible to describe the movements of assets observed between the two economic areas.

Indeed, the Governor of the Banque de France, François Villeroy de Galhau, announced on Tuesday 19 January further relocations for 2021, following on from the roughly 2,500 jobs and €170 billion in London-based assets transferred to France by the end of 2020.

For its part, the German Bundesbank reported nearly €400 billion in transferred assets, to which €100 billion from Morgan Stanley bank is expected to be added shortly.

This wave of companies migrating from central London to Europe’s main financial centres is an ideal opportunity for the EU to strengthen its own infrastructure. These capital movements are in line with the ECB’s 2019 announcement, which estimated that 24 banks and nearly €1.3 trillion in assets would eventually move from London to the eurozone.